A Study Of Chinese Commercial Banks’ Earnings Management

Earnings management is a kind of opportunistic behavior that managers use methodslike professional judgment and planning transactions to alter some items like earnings to achievevarious purposes. Though earnings management satisfies the needs of company management in theshort term, in the long run, it will, on the one hand, make part of stakeholders suffer profit loss andon the other hand, hurt the neutrality of corporate financial reporting. Compared with other listedcompanies of ordinary industries, commercial banks also have their needs and motivations forearnings management and it is the particularity of product management and capital structure thatbrings the earnings management in commercial banks particularity as well. Moreover, becausecommercial banks enjoy important status in financial industry, their behavior of earningsmanagement will result in serious economic consequences such as financial crisis.Thus, this thesis first combines commercial bank governance theories and financialtheories, and takes earnings management of commercial banks as the object of study;then based on the construction of measuring methods and measuring levels of earningsmanagement, this thesis presents a research framework that includes the economicconsequences of earnings management and the approaches to restrain earningsmanagement, which will provide objective evaluation and policy suggestions onappropriate supervision on earnings management. This thesis is divided into sevenchapters.Chapter one: Introduction. In the first chapter, the main background, theories andpractical significance of this study are introduced; then the research objectives, maincontents and technical line of this study are explained. Also, in this chapter, this thesisdefines the research methods and finally presents the major innovations of this study.Chapter two: Literature Review. As the basis of study, in this chapter, the literaturereview is conducted. Considering that commercial banks have common characters ofordinary industries, in this chapter, the thesis reviews some relevant literatures aboutearnings management in listed companies of ordinary industries, including reviewingthe literatures about the concept, motivation and measuring methods of earningsmanagement; then the thesis reviews literatures about the earnings management ofcommercial banks, including literatures about measuring methods and characteristics ofearnings management in commercial banks. Meanwhile, the thesis analyzes thesimilarities and differences of earnings management between listed companies of ordinary industries and commercial banks.Chapter three: Measurement of Level of Earnings Management of CommercialBanks in China. The research findings in this chapter are as follows: first, this thesisuses three measuring methods to measure the provision of abnormal loan losses andavoidance of earnings to measure the level of earnings management of commercialbanks in China; meanwhile, it conducts statistic analysis which tells that there isearnings management at a certain level of commercial banks in China; to be specific,the distribution of annual earnings management of commercial banks in China appearsstable without obvious fluctuation and commercial banks of all kinds have managedearnings to some extent. Second, proceeding from the perspective of behavioral finance,the thesis adopts the Prospect Theory to conduct study on earnings management ofcommercial banks in China and finds out that earnings management can be explained byProspect Theory; to be specific, when the level of earnings is below the threshold, theearnings management of commercial banks in China appears to be in a phase of risktaking while the opposite case appears to be in a phase of risk avoidance. The relationbetween earnings and risks of a commercial bank of which earnings is above thethreshold is more stable while that of the opposite case is much cliffy. Meanwhile, thethesis measures the quarterly earnings management of commercial banks in China andexamines if there is any information content in it, which tells that there is quarterlyearnings management at a certain level of commercial banks in China. In terms ofdistribution of time, earnings management extensively appears in different quarters ofdifferent years; and in terms of distribution of qualities of quarterly earningsmanagement, commercial banks of all kinds have earnings management at a certainlevel. Moreover, the testing results obtained from variance analysis of ANOVA andKruskal-Wallis H prove that the mean values of earnings management of commercialbanks in different quarters are of significant differences; and the further study revealsthat the information contents of earnings management of commercial banks in Chinaalso have quarterly otherness, and earnings management of the third and fourth quarterscan explain the stock price change, which indicates that commercial banks in China arelikely to utilize the financial report of the third quarter and the annual one to manageearnings.Chapter four: The Economic Consequences of Earnings Management ofCommercial Banks in China. The research findings in this chapter are as follows: first,through empirical test, the thesis verifies a negative correlation between the level of earnings management and business performance; in other words, the higher the level ofearnings management is, the worse the business performance will be, thus, the earningsmanagement impedes the promotion of business performance. Second, throughempirical test, the thesis verifies that the level of earnings management has influence oncash dividend policy, which reveals a negative correlation between the level of earningsmanagement and cash dividend; to be specific, the higher the level of earningsmanagement is, the lower tendency and lower amount of cash dividend distribution willbe, which means that if the level of earnings management of a commercial bank is high,then this bank is more likely not to distribute cash dividend and the degree ofdistribution of cash dividend per share is low. Thus, the earnings management ofcommercial banks in China also impedes cash dividend distribution.Chapter five: How to Restrain Earnings Management of Commercial Banks inChina. The research findings in this chapter are as follows: first, through empirical test,the thesis verifies that there is an obvious negative correlation between earningsmanagement and social responsibility of commercial banks; in other words, the betterperformance in social responsibility is, the lower the level of earnings management willbe, which proves the “Moral Standard Theory” presented by this thesis and indicatesthat commercial banks will place more emphasis on moral outlook of performing socialresponsibility by taking moral standard as premise or restraining their behaviors withmoral standard. Second, the thesis verifies that there is an obvious negative correlationbetween audit and earnings management; to be specific, the higher the audit expenselimit of accounting firms is, say, the top four international accounting firms ornewly-appointed accounting firms, the lower the level of earnings management will beand vice versa. Thus, to some extent, audit restrains earnings management ofcommercial banks, for those accounting firms are able to guide ordinary investors instock market and reduce earnings management of commercial banks.Chapter six: Policy Suggestions. Based on the previous studies, in this chapter, thethesis provides relevant policy suggestions which, on the one hand, indicate that theawareness of performing social responsibility should be strengthened and performancein social responsibility should be enhanced; on the other hand, the external audit dutyshould be strengthened to increase competitiveness of Chinese audit market. Meanwhile,the thesis suggests that supervision on commercial banks should be strengthened in bothexternal and internal aspects; internally, the governance system of commercial banksshould be completed to exercise internal supervision effect while externally, the duty of external supervision bodies should be clarified to draw up relevant policy for restraint.Chapter seven: Research Conclusions and Prospects. In this chapter, the previousresearch conclusions are summarized, and the limits of this thesis and design offollow-up study are presented.Compared with previous studies, the innovations of this thesis are as follows:In terms of the targets of study, those literatures that studied earnings managementare mostly taking the earnings management of listed companies as the target withoutpaying any effort to studying or systematically combing earnings management ofcommercial banks, and the research contents also fail to be explained deeply under suchframework. Therefore, taking Chinese commercial banks as the targets of study, thisthesis systematically studies the earnings management of commercial banks, which, onthe one hand, enriches the relevant study on earnings management, and on the otherhand, objectively evaluates the earnings management of commercial banks in China.In terms of research methods, there are two methods of measuring the level ofearnings management of commercial banks in China. One is Jones Model or JonesModified Model that are used to measure earnings management of ordinary listed banks;the other is to utilize the single index of dead account ratio of commercial banks. Bothmethods, however, fail to comprehensively reflect the business characters andcharacters of earnings management of commercial banks. Though, in recent years, someliteratures have adopted the measuring method of provision of abnormal loan loss tomeasure the level of earnings management in commercial banks, the feasibility of thismethod is relatively small. Thus, this thesis refers to and improves the previousliteratures, and based on the consideration of objects and characters of manipulation ofearnings management of commercial banks, this thesis uses three methods of measuringprovision of abnormal loan loss and avoidance of earnings losses to measure the level ofearnings management of commercial banks. Particularly, this thesis uses two methodsthat are used to measure avoidance of earnings losses to systematically measure thelevel of earnings management of commercial banks in China for the first time.In terms of research contents, the previous literatures that studied earningsmanagement of commercial banks in China are mostly centering on one certain aspectof earnings management of commercial banks in China. On the one hand, this thesissystematically measures the current state of earnings management of commercial banksin China and explains that behavior with behavioral finance; on the other hand, thisthesis verifies the economic consequences of earnings management and the methods used to restrain earnings management. In terms of the conclusions derived fromresearch contents, on the one hand, this thesis finds out that earnings management willharm the interest of minority shareholders and commercial banks, and the operatingperformance will be debased, which will result in that minority shareholders can’t getprofit from cash dividend; on the other hand, this thesis proves that earningsmanagement in commercial banks can be restrained by internally strengthening theperformance of social responsibility of commercial banks and external strict audit.